The outlook on Bahrain's retail banking system remains negative, reflecting the fragile operating environment, Moody's has said.

The Gulf kingdom faces slow economic growth prospects and heightened downside risks over the next 12-18 months, the rating agency said.

Moody's added in a new report that these conditions will in turn weigh on retail banks' domestic asset-quality and profitability metrics, although systemic risks will be mitigated by banks' healthy liquidity and relatively strong capital positions.

Moody's said the scenario assumes real GDP growth of around 3.2 percent for 2012, well below the 5.9 percent average growth recorded between 2000-10.

"Amidst the context of prevailing social unrest, the rating agency expects private-sector confidence, investment appetite and foreign direct investment to remain low over the outlook period, leading to weak business growth prospects for banks," the report said.

Moody's said a resurgence of large scale protests and/or street violence remains a downside risk, which would be detrimental to the already fragile market confidence towards Bahrain and negatively impact Bahrain's economy and banking system.

Aggregate non-performing loans (NPLs) for the largest retail banks will likely exceed eight percent of gross loans by end-2012, Moody's added, up from around 7.5 percent at end-2011.